Publishing fake research is just like shouting ‘fire’ in a crowded theatre
If you shout "fire" in a crowded theatre, there might be two reasons for doing it. One is because you actually believe there is a fire and want to share your belief. The other is because you want everyone to rush out of the theatre and leave you with the best seats. This silly example highlights a tricky problem in free speech debates. A speech act can be an act of self-expression, but it could instead be an act to achieve some other end.
We want to protect self-expression, but there are some speech acts that intend to cause outcomes that are not in the public interest.
This is the key issue brought to the fore by Viceroy Research, which is famed in SA for its reports on Steinhoff and then Capitec.
On Thursday Intellidex released a research report, commissioned by Business Leadership SA, which examines Viceroy’s research. Our view is that it is a mixed bag. There are some good elements, but also petty ad hominem attacks and juvenile sounding off about companies. Its Steinhoff report was substantially plagiarised from the report of another hedge fund, written six months earlier. Until then, Viceroy’s research was largely ignored, but its Steinhoff report, coming at a time when the market was eager for any insight into the just announced accounting mess at the company, gave it massive traction and credibility.
Viceroy was certainly shouting 'fire', but did it serve the public interest? An act may be in the public interest, even if someone was doing it for their private interest. High-quality research on a short thesis serves the public interest.
At the time Viceroy was anonymous and many myths developed about it. When investigative journalists later revealed it to be a threesome consisting of a disbarred social worker and two young Australians, the myths became more prosaic but never quite evaporated.
Viceroy retained its ability to move the market with its research reports. These were given to journalists in advance of publication, ensuring maximum publicity. Following Steinhoff it achieved this with two reports in particular, Capitec and a report on German firm ProSieben. It also published one on Advanced Micro Devices, the Nasdaq-listed Canadian chip maker, though owing to the large following of the company Viceroy had little effect. In fact its share price is up 44% since Viceroy declared it was worth "$0".
The Capitec and AMD reports were particularly weak, containing poor reasoning and false claims. But that didn’t stop share prices from being damaged. On the day of release, Capitec’s share price fell 25%, though it recovered to close 3% down, while ProSieben’s closed 6% down.
Viceroy was certainly shouting "fire", but did it serve the public interest? An act may be in the public interest, even if someone was doing it for their private interest. High-quality research on a short thesis serves the public interest, even if the writer has a financial exposure and will benefit from the price moving. But low-quality or false research does not serve the public interest at all.
This issue is important when it comes to investment research. Financial markets work because they reflect all of the information relevant to the value of assets. Analysts spend their time researching companies, poring over the numbers and producing reports. These help markets become efficient. Stocks that are followed by many analysts tend to be more efficiently priced than others in the sense that over time, the stock prices tend to more accurately reflect the prospects of those companies.
This is true of both positive and negative research. Positive research concerns shares and other assets that an analyst believes are undervalued, while negative research concerns those that analysts believe are overvalued. Good research presents the arguments, based on sound reasoning and evidence, and considers both positive and negative aspects. Such research should be encouraged. Exercises such as the Financial Mail’s annual analyst rankings (which Intellidex undertakes) are an example of mechanisms that highlight research excellence.
However, the publication of information can sometimes not be intended to share research insights, but instead to move prices. It is the financial markets equivalent of shouting "fire" so you get the best seats. The vast majority of high-quality research is circulated to a limited audience consisting of an analysts’ clients or colleagues, so it does not regularly have large-scale market impact. In such cases we can be more confident that the analyst’s work is their genuine view, rather than an attempt to move prices. However, it is more difficult to interrogate motives in the case of large-scale publication of investment research.
Large-scale publishing has been a feature of so-called activist short-selling. In such cases a hedge fund or individual takes a short position in a stock, meaning she will profit if the price falls. She then releases research that points to problems with the company, ranging from regulatory violations to problems with its business model that are not widely known.
How should we judge such research? One approach would be to assess it the same way we would assess research that is not publicly distributed. We’d consider the quality of the arguments, the evidence that has been marshalled and the professionalism in terms of objectivity and balance. The problem is that the act of publishing introduces an important dynamic. Publishing is done with a particular purpose: to affect the share price. One might say that shouting "fire" also has a purpose, which is to alert others so they can avoid harm. The analogy helps somewhat in that publishing high-quality research does have a public benefit and does help others. But what should we do when the research is of a poor quality, or, worse, based on outright falsehoods? Particularly in an age when false information can spread through social media like a wildfire?
Market manipulation has long been illegal. This refers to deliberate efforts to interfere with the functioning of a market to affect prices. Publishing false information would amount to this when the intention is to move a price. But intention is notoriously tricky.
Some bad research nevertheless reflects the fervent belief of the writer. She may strongly believe a company is worth zero, and then cherry pick the evidence to support her belief. Her belief is simply ill-founded. But this would amount to bad research, rather than an intention to manipulate the market based on false information. Alternatively, she could know that her information is false. In this case the sharing of information can only be in an attempt to manipulate the market.
Bad research would destroy credibility. If no one takes you seriously you can’t manipulate the market anyway. But when you are taken seriously, even if the reason is a plagiarised report, bad research can have a dramatic result. That is what makes the Viceroy case somewhat peculiar.
Activist short investing has become an important issue in South African markets and around the world. Much work needs to be done. Our challenge is to encourage the media to go back to the basics of good journalism instead of succumbing to the perception that speed is the most important factor. We also need to improve our regulatory regimes, in particular in SA, to enable short positions to be disclosed. Such robustness and transparency would be the equivalent of throwing up the lights in a dark theatre so that we can all see who is doing the shouting. It might be a fire marshal or a fool.
• Dr Theobald is chairman and Dr Kruger is head of strategy research at Intellidex.